Russia’s political and economic climate

Russia/CIS Riskwatch - Issue 13 - February 2018

Russia’s political elite remain upbeat about the country’s economic growth post the 2014-2016 financial crisis caused by the oil price decline and the collapse of the Russian rouble. The business community, however, does not share that optimism. Instead, Russia’s businessmen and investors want a strategic change in the country’s political structure. To them, this is the precondition for sustainable economic growth.

This article will explore this difference in opinion and what risk factors should be considered when looking to do business in Russia.

Social and political disparities: the impact on confidence in economic growth

The annual Gaidar Forum is a three-day event, held in Moscow to discuss economics, societal and political developments, and the business environment in Russia. Named after Yegor Gaidar, a renowned economist and former PM of Russia, the forum is a rare public opportunity for representatives of academic, business and official circles to discuss the pressing issues of the day.

At the January 2018 Gaidar Forum, government officials projected growth and stability for Russia, with optimistic 1.5%-2% future economic growth, record-low inflation and ambitious plans for digitalisation. However, they did not address the long-standing concerns that businessmen and investors share over the political environment in terms of widespread corruption, red tape or the continued absence of the rule of law. All factors, they feel, result in a vote of ‘no confidence’ for investment into the Russian economy.

The divide between the government and the academic and business communities became apparent due to a clever use of technology. The main auditorium at the Gaidar Forum was equipped with polling devices, and questions about the economy, reforms, foreign policy and governance were posed to the audience.

In terms of the economic outlook, a vote of low confidence was noted with 80% of the Forum’s audience of the opinion that the Russian economy has still not overcome the 2014-2016 crisis.

On the question of sanctions, the audience was asked to complete the following sentence: “Restrictive measures against Russia are . . .” More than 56% of the audience felt that sanctions were motivated by political reasons. Industry and Trade Minister Denis Manturov, however, insisted that sanctions were economically motivated and primarily aimed at protecting the interests of companies from the countries that imposed them. There were no illusions among both camps that economic sanctions from the US and EU would remain in force for the foreseeable future, effectively stunting growth.

Academics, think-tankers and business representatives also discussed the need for significant political reform. Andrey Yakovlev, professor from the Higher School of Economics in Moscow, commented that “the elites in Russia are starting to understand that the current course is unsustainable, although they do not yet understand how to enact strategic change.” If any meaningful change was to come, it would have to come from within the elite. Perhaps, such change can be spurred by unprecedented civic engagement and a political awakening across Russia.

If and when such changes do occur, business will need to be ready and have the necessary tools in place to navigate this change in a political and economic direction – as ambiguous as that may be.

But it’s not all bad news. In principle, foreign investment remains welcome in Russia. Part of President Putin’s grand plan is to notch Russia up into the top 20 countries in the World Bank’s Doing Business rankings – it’s currently ranked 35th out of 190 countries. To achieve this ranking, Putin must demonstrate that Russia is open for business, despite the Western sanctions. Indeed, there are several sectors that could present opportunities for foreign investment, particularly agriculture, mining and the IT sector. In the IT sector, there is still significant demand for foreign-made goods, despite the authorities’ preference of ‘made in Russia’ products. This is largely driven by industry specialists, who consider EU and US products to be of a better quality.

Agriculture, pharmaceuticals and mining are three sectors that could hold interesting prospects for foreign investment, particularly given the attention paid to them at the Gaidar Forum. Investments in other sectors such as oil and gas have been largely stymied by international sanctions.

However, unless Russian legislation changes, opportunities in these sectors will always be restricted. Foreigners are unable to own land and so must usually enter into a joint venture with a Russian partner, which can cause serious issues if the relationship sours.

Additional investment opportunities unfold in the Far East – a priority area of development for the Russian authorities. Since 2012, the government has invested billions into upgrading infrastructure in the Far East and setting up investment forums to attract foreign investment, particularly from Chinese and Japanese clients. Despite the government subsidies, the Far East is still badly connected and infrastructure is poorly maintained, reducing the attractiveness of the region as a logistics hub. Investors have been cautious to throw money at a region that is hampered by corruption scandals and allegations of financial mismanagement against the regional authorities.

The likely expansion of the US sanctions in the coming months presents an additional concern for foreign businesses partnering with a Russian firm whose owners could also fall under sanctions. Foreigners are also restricted from owning majority stakes in a Russian company, ensuring that their profits are somewhat limited. These challenges, coupled with the Russian government’s unwillingness to recognise and address the major impediments to an improved business climate in Russia, make it easy to understand the scepticism about Russia’s mid-term economic prospects at this year’s Gaidar Forum. All eyes will be on Putin’s next term following elections in March, and whether any of the much-needed economic reforms will finally be implemented.

Entering a new market or adopting a new project is often challenging. It is not simply a question of being able to complete the project or not, but one of delivering genuine growth for the business and mitigating against any potential risks you might encounter.